Monday, February 9, 2015

Varometer Rising?

If Greece is forced out of the euro zone, other countries will inevitably follow and the currency bloc will collapse, Greek Finance Minister Yanis Varoufakis said on Sunday.

Greece's new leftist government is trying to re-negotiate its debt repayments and has begun to roll back austerity policies agreed with its international creditors.

In an interview with Italian state television network RAI, Varoufakis said Greece's debt problems must be solved as part of a rejection of austerity policies for the euro zone as a whole. He called for a massive "new deal" investment programme funded by the European Investment Bank.

"The euro is fragile, it's like building a castle of cards, if you take out the Greek card the others will collapse." Varoufakis said according to an Italian transcript of the interview released by RAI ahead of broadcast.

The euro zone faces a risk of fragmentation and "de-construction" unless it faces up to the fact that Greece, and not only Greece, is unable to pay back its debt under the current terms, Varoufakis said.

"I would warn anyone who is considering strategically amputating Greece from Europe because this is very dangerous," he said. "Who will be next after us? Portugal? What will happen when Italy discovers it is impossible to remain inside the straitjacket of austerity?"

Varoufakis and his Prime Minister Alexis Tsipras received friendly words but no support for debt re-negotiation from their Italian counterparts when they visited Rome last week. But Varoufakis said things were different behind the scenes.

"Italian officials, I can't tell you from which big institution, approached me to tell me they backed us but they can't tell the truth because Italy also risks bankruptcy and they are afraid of the reaction from Germany," he said.

"Let's face it, Italy's debt situation is unsustainable," he added.Italy's public debt is the largest in the euro zone after Greece's and Italian bond yields surged in 2011 at the height of the euro zone crisis. They have since fallen steeply and have so far come under little pressure from the renewed tensions in Greece.

Varoufakis said his government would propose a "new deal" for Europe like the one enacted in the United States in the 1930s. This would involve the European Investment Bank investing ten times as much as it has so far, Varoufakis said.

If Europe continues to pursue counterproductive austerity policies the only people who will benefit will be "those who hate European democracy," he said, citing the Golden Dawn party in Greece, the National Front in France and the United Kingdon Independence Party in Britain.

Wednesday’s emergency Eurogroup will be crucial for Greece as its European partners will judge the country’s proposal for a new bailout program.

The new Greek government has five days to come up with a new, satisfactory financial aid plan as its proposals so far have failed to convince its European creditors and especially Germany.

Time is short for Athens as it has only five days to come up with a plan that will satisfy European finance ministers in order to prevent the worst.

Greek prime minister Alexis Tsipras also dismissed the ultimatum when he unveiled his new economic plan on Sunday and publicly stated Greece will not prolong bailout:

Mr. Tsipras said extending the bailout would be tantamount to continuing the “mistakes and disaster” of the past, and he said his government needed “fiscal space” for discussion on restructuring of debt.

“We only have one commitment: to serve the interests of our people, the good of society,” he said, noting that it was an “irreversible decision” of his government to fulfill its promises “in their entirety.”

Mr. Tsipras also pledged to replace a hated unified property tax, which combines several levies, with a new tax on large property and to increase the tax-free threshold on annual income to €12,000 from the current €5,000. Cracking down on tax evasion and corruption were also underlined as priorities.

Immediate action will be taken, he said, to restore collective wage bargaining, bringing unions back into negotiations on workers’ salaries and working conditions. He also pledged to gradually restore the minimum wage to €751 a month from €586.

As a jab at Germany, which has been leading the austerity drive in Europe, Mr. Tsipras said it was Greece’s historical duty to seek war reparations and the repayment of a loan it was forced to make to Germany in World War II.

It was basically another weekend full of Greek drama, which provided lots of doom and gloom scenarios for Zero Hedge (or as I call it, Zero Edge), which cited the Maestro himself who thinks the eurozone is finished.

Importantly, whether or not you agree with Syriza's economic plan (I certainly don't), Varoufakis is absolutely right, Grexit will not solve serious structural deficiencies that have been plaguing the eurozone since its inception, it will only bring them to the forefront and far from suppressing the southern European anti-austerity parties, it will reinforce them like never before.

This is a very important point which a lot of good economists seem to misunderstand, including John Mauldin who I respect a lot. John wrote a fantastic synopsis, The Eurozone: Collateral Damage, looking at what led to the current Greek crisis and what are the unintended consequences of a Grexit should it materialize.

There are a few things which John Mauldin got wrong in that comment, including who the ECB was really trying to pressure, why Varoufakis brought up Nazis in Berlin, and what Grexit really means for the rest of the eurozone, but he is right on the money explaining the absurdity of past bailouts which were doomed to fail and more importantly that "Greece is just a distraction from the very real crisis brewing in the rest of Europe."

The reality is the euro deflation crisis will not magically disappear until Europe's leaders stop their political dithering. Grexit will actually make things much worse, which is why U.S., British, and other powerful countries are urging European leaders to address lackluster growth once and for all (Andreas Koutras sent me President Obama's latest statement on Merkel: "I look forward to hearing Angela's assessment of how Europe and the IMF can work with the new Greek government to find a way that returns Greece to sustainable growth within the Eurozone").

Of course, to address growth, you also need to address major structural reforms and as I discussed after my last trip to the epicenter of the euro crisis and in a more recent comment on Greece's do-or-die moment, the country is in desperate need of reforming its economy and chopping its bloated public sector down to an appropriate size.

This is where my head spins listening to Alexis Tsipras defiantly proclaiming how he will do away with austerity by increasing the minimum wage, increasing pensions even if the system is at a breaking point, and hiring public sector workers that were fired because they weren't needed and the country can't afford them.

Socialism is nice in theory but in practice it's a disaster and nowhere is this more evident than in Greece where the culture of entitlement has completely warped the views of many Greeks who think they're entitled to free education, free healthcare, jobs for life in the public sector followed by cushy pensions starting at the age of 50 (pension eligibility is now 65 in Greece but many of the existing Greek pensioners got it at a much earlier age).

And by the way, this isn't just a Greek problem. It's going on all over the world, including in my own backyard of Quebec, Canada and many other places like California, Illinois, Spain, Italy, France and even the mighty Germany which has thus far managed to escape serious social upheaval (it's coming, it's only a matter of time).

Lack of structural reforms are why Greece's creditors aren't willing to give Greece an inch on debt and other reforms, and who can blame them, especially after listening to Alexis Tsipras defiantly rant on his government's new economic plan. They're rightly concerned because they don't see any intention on his part to commit to much needed reforms.

It could all get very messy. But there are broadly three possible outcomes: the good, the disastrous, and a compromise to kick the can down the road. The history of the euro has always been to defer the pain, but now the battle is about politics not economics—and compromise may be much harder.

Tantalisingly, there is a good solution to be grabbed for both Greece and Europe. Mr Tsipras has got two big things right, and one completely wrong. He is right that Europe’s austerity has been excessive. Mrs Merkel’s policies have been throttling the continent’s economy and have ushered in deflation. The belated launch of quantitative easing (QE) by the European Central Bank admits as much. Mr Tsipras is also right that Greece’s debt, which has risen from 109% to a colossal 175% of GDP over the past six years despite tax rises and spending cuts, is unpayable. Greece should be put into a forgiveness programme just like a bankrupt African country. But Mr Tsipras is wrong to abandon reform at home. His plans to rehire 12,000 public-sector workers, abandon privatisation and introduce a big rise in the minimum wage would all undo Greece’s hard-won gains in competitiveness.

Hence this newspaper’s solution: get Mr Tsipras to junk his crazy socialism and to stick to structural reforms in exchange for debt forgiveness—either by pushing the maturity of Greek debt out even further or, better still, by reducing its face value. Mr Tsipras could vent his leftist urges by breaking up Greece’s cosy protected oligopolies and tackling corruption. The combination of macroeconomic easing with microeconomic structural reform might even provide a model for other countries, like Italy and even France.

A very logical dream—until you wake up and remember that Mr Tsipras probably is a crazy leftwinger and Mrs Merkel can barely accept the existing plans for QE. Hence the second, disastrous outcome: Grexit. Optimists are right that it would now be less painful than in 2012, but it would still hurt.

In Greece it would lead to bust banks, onerous capital controls, more loss of income, unemployment even higher than today’s 25% rate—and the country’s likely exit from the European Union. The knock-on effects of Grexit on the rest of Europe would also be tough. It would immediately trigger doubts over whether Portugal, Spain and even Italy should or could stay in the euro. The euro’s new protections, the banking union and a bail-out fund, are, to put it mildly, untested.

So the most likely answer is a temporary fudge—but it is one that is unlikely to last long. If Mr Tsipras gets no debt relief, then he will lose all credibility with Greek voters. But even if he wins only marginal improvements in Greece’s position, other countries are bound to resist. Any changes in the bail-out terms will have to be voted on in some national parliaments, including Finland’s. If they passed, voters in countries like Spain and Portugal would demand an end to their own austerity. Worse still, populists from the right and left in France and Italy, who are not just against austerity but against their countries’ membership of the euro, would be strengthened.

And there are technical problems with any fudge. The ECB is adamant that it cannot provide emergency liquidity to Greece’s banks or buy up its bonds unless Mr Tsipras’s government is in an agreed programme with creditors, so any impasse is likely to trigger a run on Greek banks. By stretching out maturities, some of this could be avoided—but that may be too little for Mr Tsipras and too much for Mrs Merkel.

Hello to Berlin

So in the end, Greece will probably force Europe to make some hard choices. With luck it will be towards the good outcome outlined above. Greek voters may be living in a fool’s paradise if they think Mr Tsipras can deliver what he says, but the Germans too have to look at the consequences of their obstinacy. Five years after the onset of the euro crisis, southern euro-zone countries remain stuck with near-zero growth and blisteringly high unemployment. Deflation is setting in, so debt burdens rise despite fiscal austerity. When policies are delivering such bad outcomes, a revolt by Greek voters was both predictable and understandable.

If Mrs Merkel continues to oppose all efforts to kick-start growth and banish deflation in the euro zone, she will condemn Europe to a lost decade even more debilitating than Japan’s in the 1990s. That would surely trigger a bigger populist backlash than Greece’s, right across Europe. It is hard to see how the single currency could survive in such circumstances. And the biggest loser if it did not would be Germany itself.

Greece may be near-insolvent, its pensioners huddled over wood stoves in freezing flats without electricity, but – says Syriza – it stakes a superior claim than Germany when it comes to the creation of Europe and modernity. It may be at the bottom of the economic pecking order, but Europe was supposed to be more than an economy. Greece, like Germany, is a strong, visceral state of mind. If nations were measured by the salience of their culture – its bite, its saltiness, its addiction to beauty – Hellenic culture would stand equal to its Teutonic counterpart. And that is what makes the economic clash of will so visceral, too.

What’s about to happen is a fight to the death. Either Germany drives Greece to insolvency, and out of the eurozone, or the German taxpayer signs up to an outcome that flies in the face of the rules-based mentality at the heart of German culture.

Germany needs to handle this carefully; the rest of Europe is watching. My pals and I from the bubblegum card era were brought up in a country that had not seen occupation or fascism or genocide. Greece saw all of these, and Syriza’s victory has opened a floodgate of discussions about the past at Greek dinner tables. The popular Greek response to the ECB’s move last week is in danger of taking on the character of national revolt: a replay of the Battle of Crete, where the Greeks lose physically but win morally, at irreparable cost to the attacker.

That imagery like this is being thrown around in modern Europe is a testimony to how badly modern Europe is failing.

Indeed, this is a sad state of affairs and I blame Europe's economic malaise on all its leaders who have been dithering for far too long while the world sinks further into global deflation (their inaction has exacerbated this dangerous deflationary spiral).

But all is not lost, at least not yet. While relations between Greece and its eurozone creditors have reached a new low, Larry Elliott of the Guardian is right, a Greece debt deal is by all means not impossible, provided Tsipras shows a willingness to continue the reforms of the Greek economy.

The austerity and reform program imposed by Greece’s “troika” of lenders—the European Central Bank (ECB), European Commission (EC) and International Monetary Fund—obviously hasn’t been an unalloyed success. It has kept Greece current on its debts, but it hasn’t revived its economic growth. Varoufakis proposes that Greece’s future debt payments be tied to the country’s economic growth.

It’s a simple idea: if Greece grows quickly, its debt payments go up; if Greece doesn’t grow, its debt service falls, even as low as zero. There’s no incentive for the government in Athens to game the economy to avoid triggering debt payments: even a heterodox left-winger like Varoufakis knows that Greece needs to grow if he’s to hold on to his job.

But the few countries that have recently put the concept into practice are not exactly poster children for economic probity. Argentina issued GDP-linked warrants as a bonus for creditors willing to be forced into its hard-nosed “take it or leave it” 2005 debt restructuring. Greece included a similar sweetener in its 2012 debt write-down with private bondholders.

Nonetheless, tying debt repayment to economic circumstance does have a more honorable history. John Maynard Keynes negotiated similar terms (paywall) on a 1946 American loan provided to get post-war Britain back on its feet. Interest payments on the loan were suspended in any year that the UK’s foreign-exchange earnings fell below pre-specified minimums.

This should be the future of how we lend to many countries—especially the very poor 50 or so nations that attract almost no private foreign investment, and vulnerable emerging markets that depend heavily on commodity exports. If more countries converted to issuing growth-linked debt, it would reduce the need for acrimonious debt restructuring negotiations during crises (as in Argentina’s case) or for the equivalent of a bankruptcy court for countries (there currently isn’t one). Instead, when countries run into hard times, their debt payments would automatically be suspended while they sort out their affairs.

Schäuble and Varoufakis ought to be able to reach common ground on tying Greece’s debt payments to the country’s GDP. If Germany truly believes the troika’s policy package will produce growth, there’s no doubt that it and its euro-zone partners will be paid.

However, Schäuble does have a legitimate reason to be skeptical. Growth-indexed debt requires credible GDP data, and Greece’s data aren’t credible. After all, it was the country’s chronic fiddling of its public deficit numbers that touched off this crisis. Greece’s government reacted badly when the jiggery-pokery was revealed: It threw in jail the head of the government statistical office (and former IMF economist), Andreas Georgiou, who revealed the fraud. At the time, Georgiou noted (paywall), “I am being prosecuted for not cooking the books… Unfortunately, in Greece statistics is a combat sport.”

So don’t trust Greek numbers. Instead, end the impasse between Athens and Berlin by stationing a few more EC and IMF economists in the Greek statistical agency. Parachute in a whole flotilla of them, make sure Greek data are sound, and tie Greece’s future debt payments to its economic success. The salaries of these statistical gurus would be nothing compared to the collateral damage that would be wrought if Greece and Germany remain at loggerheads, the troika program lapses, and Athens defaults on its debt.

As Varoufakis recently said to the German paper Die Zeit, “You need not trust us. But you should listen to us.” This is why linking Greece’s debt payments to the country’s growth is such a good idea: no one has to trust the Greeks for it to work.

It is appealing. My concern is that during growth periods, one theory holds that countries should tax more. Their citizens can afford it (as it's a growth period) and the government can save the money for periods of difficulty. An improperly designed warrant system, which pays debtors during periods of growth could compromise Greece's ability to increase its coffers, leaving it vulnerable to the next downturn.

But it is really worth thinking about. Greece will need external financing and this is one way to get investors comfortable.

There is one flaw, that the writer refers to, even though he says this:

"There’s no incentive for the government in Athens to game the economy to avoid triggering debt payments:.."

Of course there's an incentive for the government to game the system. Growth is going to be X. That's going to be a fact. And the government will collect a percentage of X in tax revenues. BUT - if the government can say that growth will be less than X, they'll have to pay less on the debt. Argentina plays those games. I'm not sure his solution of adding in some observers to the finance ministry will work.

Nathan also shared his thoughts on the Greek crisis:

In the short run, we may see the Europeans kick the can down the road, giving a short-term extension/bailout.

One of the interesting things in Mauldin's comment was the comment about Greece turning to Russia or China. I've never thought about that. But Russia doesn't have cash and Greece doesn't have much China would want. And neither of these two saviors would be interested in funding Greece and watching their money flow right out the door to pay interest on European debt.

The long term solution may be to cut rates to 0.1% on the debt, keeping the principal outstanding, but subordinating it to all other debt, even new debt. That weaselly solution would allow Europe to say that Greece still owes the debt and allow Greece to borrow more and not have the debt hurt their economy.

If Greece leaves the Euro, I think it still stays in the EU. Just too much of a hassle otherwise. And even if Greece leaves, none of the countries want a 3rd world country on their doorstep. It's in everyone's best interest to help Greece survive the upheaval.

As I explained here, the pivot toward Russia is pure nonsense, if anything Tsipras and Varoufakis are American puppets put there to shake things up in Europe and protect American interests. Also, the Chinese do have a vested interest to develop Athens' port but they're uneasy with comments from Syriza stating these privatizations will be scrapped.

But I agree with Nathan, it's in everyone's best interest to help Greece survive this upheaval. Europe and the world can't afford another potential Lehman moment, especially now that global deflation is knocking on our doorstep, threatening the global economy and pensions (Read Lacy Hunt's latest comment on deflation).

Let me also publicly state that the latest developments in Greece have caused quite a few heated exchanges with Greek Canadian friends of mine who think Varoufakis and Tsipras are on a path of destruction and sheer lunacy. I remind them that no matter what we think of Syriza, they were elected with a platform to put an end to the madness of dismal austerity. And no matter what happens over the next week, Greece faces a long and arduous road to recovery.

As for the title of this comment, it comes from an Al Jazeera article on Yanis Varoufakis, the Greek Varometer, and I played on the title of a classic Canadian novel, Hugh MacLennan's Barometer Rising. MacLennan's book is an allegory of Canada's shift away from the political and cultural influences of colonial, Imperial Britain to a decolonized independence and emergent national consciousness throughout the course of the first World War. The mythological template of Homer's Odyssey is clearly in evidence throughout the book.

I also embedded a 2011 Ted Academy Talk where then professor Yanis Varoufakis discussed his Modest Proposal and his vision for a decentralized Europe and what is needed to prevent a systemic crisis. I recommend you listen to this talk and read Varoufakis's book, The Global Minotaur.

I think the Greek Varometer is very misunderstood and beyond the Marxist, socialist veneer, he's been highlighting serious structural deficiencies that continue to plague the eurozone. If his counterparts dismiss his views, they risk creating a much worse crisis, one the world cannot afford.

Having said this, Mr. Varoufakis and Mr. Tsipras need to recognize eurozone's creditors don't owe Greece perpetual funding based on their "common heritage." Greeks have to finally put an end to decades of public sector profligacy and insane regulations and demonstrate to their eurozone partners they truly deserve to be part of this imperfect but important union. And that's no modest proposal!

Also, Columbia economics professor and Nobel laureate, Joseph Stiglitz, wrote an excellent article for Project Syndicate, A Greek Morality Tale. Stiglitz ends by stating: "One hopes that those who understand the
economics of debt and austerity, and who believe in democracy and humane
values, will prevail. Whether they will remains to be seen."

But in his stark comment, Analtole Kaletsky of Reuters writes Greece is playing a losing game. He states: "Greece’s idealistic new leaders seem to
believe that they can overpower bureaucratic opposition without the
usual compromises and obfuscations, simply by brandishing their
democratic mandate. But the primacy of bureaucracy over democracy is a
core principle that EU institutions will never compromise." Let's hope he's dead wrong.

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